Preferred beneficiary versus qualifying disability trust elections

By AdvocateDaily.com Staff

Electing to make a testamentary trust a qualifying disability trust (QDT) is not always the best option for beneficiaries with special needs, Ottawa disabilities and estate planning lawyer Kenneth Pope tells AdvocateDaily.com.

Pope, principal of Kenneth C. Pope Law, explains that testamentary trusts were once a “very advantageous tax-splitting mechanism” because they were taxed at marginal rates in line with income bands for individuals.

“By having multiple testamentary trusts, you could split the income between different trusts, and benefit from the lower rates,” he says.

But the rules were changed in 2016 so that all testamentary trusts would be taxed at the top marginal rate of about 50 per cent.

And while QDTs were exempted from the rules, Pope says it’s often not the most tax-efficient option for Henson trusts, which were initially designed to protect the inheritance of children with special needs.

“On the face of it, it seems like the QDT election is advantageous, but curiously, it’s not always the case,” Pope says.

If a Henson trust beneficiary qualifies for the disability tax credit, he says they may save more money by using a preferred beneficiary election, which allows any trust income to be attributed to the beneficiary, he says.

Every year, the trust files a nil tax return, while the beneficiary reports the trust income on their personal return. For a Henson trust delivering $20,000 in annual income, Pope says a beneficiary could end up paying zero tax on that amount, compared with a QDT trust, which will be charged about 22 per cent, and a normal testamentary trust, which is charged the top marginal rate of about 50 per cent.

“It’s a purely paper transaction, and there’s no effect on any provincial disability benefits,” Pope says. ”It’s also not a very complicated arrangement to set up.”

He says the math may change for trusts where the annual income is at the higher end.

“If the trust is generating more than $65,000, you might consider the QDT election, or if you have multiple trusts that are all generating more than $65,000, then you might have one that you elect to be a QDT trust, but that’s very rare,” Pope adds.